Setting the right prices for your products is a balancing act. A low price isn't always ideal, as the product might see a healthy stream of sales without turning any profit (and we all like to eat and pay our bills, right?). Similarly, when a product as a high price, a retailer may see fewer sales and “price out” more budget-conscious customers, losing market share.
Ultimately, every small business will have to do their homework. Retailers have to consider factors like production and business costs, revenue goals, and competitor pricing. Even then, setting a price for a new product, or even an existing product line, isn’t just pure math. In fact, that may be the most straightforward step of the process.
That’s because numbers behave in a logical way. Humans, on the other hand—well, we can be way more complex. Yes, you need to do the math. But you also need to take a second step that goes beyond hard data and number-crunching.
The art of pricing requires you to also calculate how much human behavior impacts the way we perceive price.
To do so, you’ll need to examine different pricing strategies, their psychological impact on your customers, and make your decision from there.
1. Retail price: Choosing the right pricing strategy for your brand
Many retailers benchmark their pricing decisions using keystone pricing (explained below), which is essentially doubling the cost of the product to set a healthy profit margin. However, in many instances, you'll want to mark up your products higher or lower, depending on your specific situation.
Here’s an easy formula to help you calculate your retail price:
Retail Price = [(Cost of item) ÷ (100 - markup percentage)] x 100
For example, you want to price a product that costs you $15 at a 45% markup instead of the usual 50%. Here's how you would calculate your retail price:
Retail Price = [(15) ÷ (100 - 45)] x 100
Retail Price = [(15 ÷ 55)] x 100 = $27
While this is a relatively simply markup formula, this pricing strategy doesn’t work for every product in every retail business. Because every retailer is unique, we’ve rounded up 10 common pricing strategies and weighed the advantages and disadvantages of each to make your decision-making simpler.
2. Manufacturer suggested retail price: What is MSRP?
As the name suggests (no pun intended), the MSRP is the price a manufacturer recommends retailers use when selling a product. Manufacturers first started using MSRPs to help standardize different prices of products across multiple locations and retailers.
Retailers often use the MSRP with highly standardized products (i.e., consumer electronics and appliances).
- Pros: As a retailer, you can save yourself some time simply by using the MSRP when pricing your products.
- Cons: Retailers that use the MSRP aren’t able to compete on price—with MSRPs, most retailers in a given industry will sell that product for the same price.
3. Keystone pricing: A simple markup formula
This is a pricing strategy that retailers use as an easy rule of thumb. Essentially, it’s when a retailer would simply double the wholesale cost they paid for a product to determine the retail price. Now, there are a number of scenarios in which the price of a product using keystone pricing may be too low, too high, or just right for your business.
If you have products that have a slow turnover, have substantial shipping and handling costs, and are unique or scarce in some sense, then you might be selling yourself short with keystone pricing. In any of these cases, a retailer could likely use a higher markup formula to increase the retail price for these in-demand products.
On the other hand, if your products are highly commoditized and easily available elsewhere, using keystone pricing can be harder to pull off.
- Pros: The keystone pricing strategy works as a quick-and-easy rule of thumb that ensures an ample profit margin.
- Cons: Depending on the availability and the demand for a particular product, it might be unreasonable for a retailer to markup a product that high.
4. Multiple pricing: The pros and cons of bundle pricing
We’ve all seen this pricing strategy in grocery stores, but it’s common for apparel as well, especially for socks, underwear, and t-shirts. With the multiple pricing strategy, retailers sell more than one product for a single price, a tactic alternatively known as product bundle pricing.
For example, a study looking at the effect of bundling products found in the early days of Nintendo's Game Boy handheld console, it sold the most products when the devices were bundled with a game rather than individual products alone.
- Pros: Retailers use this strategy to create a higher perceived value for a lower cost—which can ultimately lead to driving larger volume purchases.
- Cons: When you bundle products up for a low cost, you'll have trouble trying to sell them individually at a higher cost, creating cognitive dissonance for consumers.
5. Penetration pricing and discount pricing
It’s no secret that shoppers love sales, coupons, rebates, seasonal pricing, and other related markdowns. That’s why discounting is a top pricing method for retailers across all sectors, used by 97% of survey respondents in a study from Software Advice.
There are several benefits to leaning on discount pricing. The more apparent ones include increasing foot traffic to your store, offloading unsold inventory, and attracting a more price-conscious group of customers.
- Pros: The discount pricing strategy is effective for attracting a larger amount of foot traffic to your store and getting rid of out-of-season or old inventory.
- Cons: If used too often, it could give you a reputation of being a bargain retailer and could hinder consumers from purchasing your products for regular prices.
Penetration pricing is also a marketing strategy that's useful for new brands. Essentially, a lower price is temporarily used to introduce a new product in order to gain market share. The tradeoff of additional profit for customer awareness is one many new brands are willing to make in order to get their foot in the door
For more information on how to build a discount pricing strategy, read these related posts on the topic:
- How to Offer Retail Discounts Without Slashing Your Profits
- The Science of Sales: How to Move More Merchandise with Discounts
6. Loss-leading pricing: Increasing the average transaction value
We’ve all done this: We walk into a store lured by the promise of a discount on a hot-ticket product. But instead of walking away with only that product in hand, you ended up purchasing several others as well.
If so, you’ve gotten a taste of the loss leader pricing strategy. With this strategy, retailers attract customers with a desirable discounted product and then encourage shoppers to buy additional items.
A prime example of this strategy is a grocer that discounts the price on peanut butter and promotes complementary products like loaves of bread, jelly and jam, and honey. The grocer might offer a special bundle price to encourage customers to buy these complementary products together rather than simply selling a single jar of peanut butter.
While the original item might be sold at a loss, the retailer benefits from the other products customers purchase while in-store.
- Pros: This tactic can work wonders for retailers. Encouraging shoppers to buy multiple items in a single transaction not only boosts overall sales per customer but can cover any profit loss from cutting the price on the original product.
- Cons: Similar to the effect of using discount pricing too often, when you overuse loss-leading prices, customers come to expect bargains and will be hesitant to pay the full retail price.
FURTHER READING: Learn how bundling your products can help you increase your retail sales.
7. Psychological pricing: Use charm pricing to sell more with odd numbers
Studies have shown that when merchants spend money, they're experiencing pain or loss. So, it’s up to retailers to help minimize this pain, which can increase the likelihood that customers will make a purchase. Traditionally, merchants have accomplished this with prices ending in an odd number like 5, 7, or 9. For example, a retailer would price a product at $8.99 instead of $9.
In William Poundstone’s book Priceless, he picks apart eight studies on the use of charm prices (i.e. those ending in an odd number), and found that they increased sales by 24% on average when compared to their nearby, ’rounded’ price points.
But how do you choose which odd number to use in your pricing strategy? The number 9 reigns supreme when it comes to many retail pricing strategies. Researchers at MIT and the University of Chicago ran an experiment on a standard women's clothing item with the following prices $34, $39, and $44. Guess which one sold the most?
That's right—pricing the item at $39 even outsold its cheaper counterpart price of $34.
- Pros: Charm pricing allows retailers to trigger impulse purchasing. Ending prices with an odd number gives shoppers the perception that they’re getting a deal—and that can be tough to resist.
- Cons: When you're selling luxury goods, lowering your price from a whole number like $1,000 to $999.99 can actually hurt your brand’s perception. This pricing strategy can give luxury customers the impression that the products are defective or are market down for a similar reason.
8. Competitive pricing: Beating out the competition
As the name of this pricing strategy suggests, comparative pricing refers to using competitor pricing data as a benchmark and consciously pricing your products below theirs.
Outpricing your competitors can influence price-conscious customers to purchase your products over similar ones. However, this “race to the bottom” from a pricing perspective isn’t always the best strategy for every business and product.
Here’s how we sum up the advantages and drawbacks:
- Pros: This strategy can be effective if you can negotiate with your suppliers to obtain a lower cost per unit while cutting costs and actively promoting your special pricing.
- Cons: This can be difficult to sustain when you’re a smaller retailer. Lower prices mean lower profit margins, and so you’ll have to sell higher volume than competitors. And, depending on the products you’re selling, customers may not always reach for the lowest-priced item on a shelf.
9. Premium pricing: Above competition pricing
Here, you take the pricing strategy from above and go to the other end of the spectrum. Brands benchmark their competition but consciously price products above theirs and brand themselves as more luxurious, prestigious, or exclusive. For example, a premium price works in Starbucks' favor when people pick them over a lower-priced competitor like Dunkin' Donuts.
A study from economist Richard Thaler looked at people hanging out on a beach wishing for a cold beer to drink. They’re offered two options in this scenario: purchasing a beer at either at a run-down grocery store or a nearby resort hotel. The results found that people were far more willing to pay higher prices at the hotel for the same beer. Sounds crazy, right? Well, that's the power of context and marketing your brand as high-end.
- Pros: This pricing strategy can work its “halo effect” on your business and products. Consumers perceive that your products are better quality and more premium due to the higher price compared to competitors.
- Cons: This pricing strategy can be difficult to implement, depending on your stores’ physical locations and target customers. If customers are price-sensitive and have several other options to purchase similar products, the strategy won’t be effective. This is why it’s crucial to understand your target customers and do market research.
FURTHER READING: Learn how to conduct market research to take the guesswork out of setting prices, your target customers, and quirks of your chosen niche.
10. Anchor pricing: Creating a reference point for shoppers
Anchor pricing is another psychological pricing tactic retailers have used to create a favorable comparison. Essentially, a retailer lists both a discounted price and the original price to establish the savings a consumer could gain from making the purchase.
Amazon uses anchor pricing to spur more sales. Image: Bonza Marketing
Creating this kind of reference pricing (placing the discounted and original prices side-by-side) triggers what’s known as the anchoring cognitive bias. In an MIT study from Dan Ariely, students were asked to write down the last two digits of their social security number and then consider whether they would pay this amount for items that they didn't know the value of—in the experiment, they used examples like wine, chocolate, and computer equipment.
Next, they were then asked to bid for those items. Dr. Ariely found that students with a higher two-digit number submitted bids that were 60-120% higher than those with lower security numbers. That’s due to the higher price “anchor,” i.e. their social security number. Consumers establish the original price as a reference point in their minds, then “anchor” to it and form their opinion of the listed marked-down price.
The other way you can take advantage of this principle is to intentionally place a higher-priced item next to a cheaper one to draw a customer's attention to it.
Many brands across industries use anchor pricing to influence customers to purchase a mid-tier product. Image: Price Intelligently.
To sum up, here are the primary advantages and disadvantages of the anchor pricing strategy:
- Pros: If you list your original price as being much higher than the sale price, it can influence a customer to make a purchase based on the perceived deal.
- Cons: If your anchor price is unrealistic, it can lead to a breakdown of trust in your brand. Customers can easily price-check products online against your competitors—so ensure your listed prices are reasonable.
How to set wholesale prices for products
Once you have your suggested retail price (SRP), you can move forward with creating a wholesale pricing strategy for your products. This is a necessary process for retail brands that want to delve into business-to-business (B2B) sales.
Retailers will sell their products at a discounted price to another business to resell to their own customers. This can increase a brand’s reach and introduce its products to new audiences.
To set a wholesale pricing strategy, start with the following steps:
- Calculate the cost of goods manufactured (COGM): This is the total cost of making or purchasing a product, including materials, labor, and any additional costs necessary to get the goods into inventory and ready to sell, such as shipping and handling.
A product’s COGM can be determined with the following calculation:
Total Material Cost + Total Labor Cost + Additional Costs and Overhead = Cost of Goods Manufactured
- Protect your profit margin: Keep in mind that when setting a wholesale pricing strategy, the profit margin should be 50% or more.
Retail margin percentage can be determined with the following formula:
Retail Price - Cost / Retail Price = Retail Margin %
- Set your direct-to-consumer and business-to-business prices: That means you’d create an external retail price for your products listed on your website that your direct customers see and a separate wholesale price you share with wholesale or potential wholesale accounts in the form of a line sheet. When you sell wholesale, you're likely selling a higher quantity in each order, which allows you to sell the products at a lower price.
FURTHER READING: For more details on setting a wholesale pricing strategy, read our step-by-step guide to creating B2B prices for your products.
Moving forward with the right pricing strategy
There’s never a black-and-white approach to setting a pricing strategy. Not every pricing strategy will work for every kind of retail business—every brand will need to do their homework and decide what works best for their products and target customers.
Now that you have a deeper understanding of some of the most common pricing strategies for retail businesses, you can make a more informed choice.